TMI BlogGUIDANCE NOTE ON PERFORMANCE APPRAISAL REPORT (Form-III ) - November, 2012X X X X Extracts X X X X X X X X Extracts X X X X ..... prove the performance of the organization as a whole. Effective performance measures can let us: Monitor performance to judge how well the company is fairing, Know if company management is meeting its goals. If appropriate actions have been taken to affect performance or improve efficiency if improvements are necessary. There is no set number or formula to determine how many performance measures an organization should have. Tracking too many performance measures at once may cause managers to lose sight of which ones contribute directly to strategic objectives. On the other hand, having too few measures may not tell a good story about your work. Since the Performance Appraisal Report is to be submitted to the Board of Directors of the Company, the performance measures which will be appraised should be discussed with the Company Management and then finalized for analysis and reporting thereof. This guidance is not on strategic management in companies but using strategic management process in the context of performance analysis of companies under Cost Audit provisions of the Companies Act, 1956 . The guidance note is also not a prescriptive but a suggestive mo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ponses, to the Institute for larger benefits. 2. PERFORMANCE ANALYSIS: The rationale of Performance Appraisal Report (PAR) 2.1 The basic objective of Performance Appraisal Report is to provide an actionable insight into costs and profitability for the management in the strategic and operational context. It aims at discovering various drivers of costs and profitability and their impact on the selected performance variables. It would help the organisations: to improve profits and profitability to optimize resource allocation to optimize the product and services portfolio 2.2 The Performance Appraisal Report is to be provided only to the company under cost audit. The form III is NOT to be submitted to anyone else. In that sense, this report is a confidential and not public document. According to the rule 4 (5) of the Companies (Cost Audit Report) Rules 2011 , the Performance Appraisal Report should be submitted to the Board or Audit Committee of the Board of the company. 2.3 The objective is to provide the management objective assessment of the performance of the organisation across various spectrums. It inter-alia aims at satisfying the g ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... be used by the company and this report is confidential. 4.2 The report, being an annexure to the cost audit report, should basically lay more thrust on the cost management aspect of the business and should effectively bring out comments on how the business performance could be improved by elevating the cost performance. 4.3 When commenting on or analyzing the cost performance, the cost auditor could assess the impact of changes in the costs on the profitability of the products, profitability by customers or market segments. 4.4 The cost drivers that are the fulcrum of the cause and effect relationship in the cost statement, are the ones which form the first level of KPIs that are easily understood and actionable for the operational executives. The cost auditor while evaluating the KPIs can also look at the efficacy of the cost drivers. This evaluation will also enable the operational executives to relate what is being done at the shop floor to the cost statements that are the end product of the cost accounting system. 4.5 It would be necessary to analyze the use of various resources to boost economy, efficiency and effectiveness of the operations. Economy indica ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s products, services, and the processes. Effective performance measures can let us: Monitor performance to judge how well the company is doing, Know if company is meeting its own set goals and if the customers are satisfied, Take action to affect performance or improve efficiency if improvements are necessary. So we need to identify appropriate Performance measures so that the analyst is provided data and information necessary to make informed decisions. Performance measures provide a snapshot of current performance capabilities and track whether actual performance is getting better, staying the same, or getting worse over time. Machine hour rate is a performance measure which provides us inputs for various decisions. Capital expenditures tell about the investment of funds; we communicate the return on that investment through performance measures. 5.3 Keep the focus of the chosen performance measure on things that matter most, such as: Are we accomplishing our mission to analyze the performance? Are the processes achieving strategic goals and objectives? Are the customers satisfied? Are various processes being managed by the company ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ties that were impacted by the strategies selected and also implemented during the year of cost audit. 6.4 Analyze the cost implications of those activities and link it with the expected results of the strategies. 6.5 Present the evaluation, in a table or any other easily comprehensible format like histogram, chart, graph etc. 6.6 Give explanatory notes for the terms used, calculations made, and assumption behind the evaluations. 6.7 Finalize the finding after a discussion with the concerned operating executives and then with the management of the company. 7. General Guidance on the first time preparation of Performance Appraisal Report 7.1 The Performance Appraisal Report being the part and parcel of the cost audit report, it would apply in all the cases where Companies (Cost Audit Report) Rules, 2011 apply with effect from 1st April 2011. 7.2 Before preparing the Performance Appraisal Report for the first relevant year, the following approach is recommended to be adopted by the cost auditor: The cost auditor first must clearly understand the nature of business operations of the company, its segmentation, the environment within which the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... collected and analysed for more than one reporting period. The cost auditor could summarize the plan in order to have clarity. A suggestive format of the plan is given in the Appendix- A 7.3 Once the terms of Performance Appraisal Report are agreed upon as above, the cost auditor should ensure that the company has the underlying information system which could throw up the data required for the preparation of Performance Appraisal Report. In case, the existing system is insufficient, the cost auditor could hold discussions with the IT head of the company. 7.4 The cost auditor is recommended to have a personal hearing from the head or member of the audit company and discuss the Performance Appraisal Report templates with them. The templates of Performance Appraisal Report could then be finalised. 7.5 The cost auditor should make a presentation to the general management team and the members of audit committee. This presentation should highlight the performance metrics selected for the Performance Appraisal Report, the logic of selecting them, and the way they would help the company to review its performance. The cost auditor should then present his independent ev ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nd format of the Performance Appraisal Report. 8.4 It would be pertinent to highlight the effect of such changes on the overall performance of an organisation and also how these factors could potentially drive the future performance of the company. 8.5 The cost auditor should comment on the feedback on the previous year's Performance Appraisal Report. There may suggestion made in the previous year on which the management may have agreed to act upon. The Performance Appraisal Report should comment on the actions taken by the management and the outcome thereof. This is essential to ensure no issue remains open. 8.6 The Performance Appraisal Report would also highlight the success achieved as a result of suggestions made in the Performance Appraisal Report of the previous year/s. It is required to officially document the usefulness of the Performance Appraisal Report for the organisation. 9. Guidance on indicative contents of the Performance Appraisal Report 9.1 The form III of the Companies (Cost Audit Report) Rules 2011 has provided an indicative list of the contents. The critical parameters that have to be concentrated upon may differ from industry to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... g: Horizontal and vertical analysis of quantitative figures Trend analysis of performance parameters reflecting 3-10 years' figures Qualitative comments with interpretations of the cost auditor Comparison with external benchmarks such as industry average 10. Capacity Utilisation Analysis 10.1 The basic quantitative information on capacity is covered in the Para 4 - Quantitative Information to the annexure to the cost audit report. However, this information is only indicative and does not provide analytical review. Capacity is usually expressed in terms of the final cost unit and where not so possible in terms of machine hours, people hours etc. 10.2 The concept of capacity is highly subjective. While on one hand it denotes the availability of resources, it would also mean the maximum rate at which the company can produce goods or services. Capacity does have considerable impact on the profitability. The cost auditor should assess this impact by analyzing and relating the impact of capacity costs on profitability. 10.3 The cost auditor should collect information of theoretical capacity, practical capacity, normal capacity and budgeted ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... additional references Cost Accounting Standard (CAS- 2) - Capacity Determination issued by the Institute of Cost Accountants of India CAM-I capacity model developed by Consortium for Advanced Manufacturing -International, Texas Capacity Utilisation Bottleneck Efficiency System (CUBES) model SEMATECH's approach to Overall Equipment Effectiveness (OEE) Theory of constraints model (TOC) Balanced Score Card - by Robert Kaplan AA1000APS (Principles) AA1000AS (Assurance) AA1000SES (Stakeholder Engagement) 11. Productivity and Efficiency Analysis 11.1 Productivity involves variables of input resources and the output. Measuring, identifying and isolating the different input resources and analyzing their contribution to produce goods and services and their effect on costs and profitability is imperative for improving business performance. It should be noted carefully that productivity is a measure of efficiency per unit of output, whereas efficiency is generally measured in totality. 11.2 The cost auditor could understand and analyse the whole chain of input-processing-output. This analysis, while traditional and very ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... g: The Bill of Material (BOM) for each product The standard cost card, if any Internal reports on consumption, wastages per unit of input to capture actual data Production scheduling and plans to measure labour machine time productivity External benchmarking such as industry norms, best practices data etc. used by the company or generated by cost auditor for analysis 11.6 Suggested additional references: Publications by the Indian Productivity Council Industry association reports like Indian Machine tool manufacturers, Society for Indian Automobile Manufacturers, etc. to get the data on Industry averages for benchmarking 12. Utilities and Energy Efficiency Analysis 12.1 This is an extended analysis of single factor productivity in respect of the utilities and energy inputs acquired and consumed by the company. The importance of conservation of nonrenewable energy needs no emphasis. 12.2 The utilities are resources that are used in the process of conversion of material and other components into a finished product, but these resources do not form part of the physical unit of the product. In manufacturing industries, util ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ment of major items of cost, their relationship with the volume of production and impact on the profitability. Para 6 -Annexure to the cost audit report provides information (for each product group) on operating ratios for the current and previous years. These ratios are computed as proportion of individual cost elements to the cost of sales. 13.3 The cost auditor could provide analysis of the cost information by highlighting any significant variation therein during the reporting period. These variations are caused by non-recurring, onetime costs that may vitiate the ratios. Suggestions to avoid such variations may be provided in the report. This could be having long term rate contracts, supplier agreements, consumption controls etc. 13.4 The cost information should include comparison of actual cost performance with the standards or budgets as the case may be. If the company is using target costs, the cost auditor could identify the cost gap and recommend the ways to reduce the same. The report should provide a commentary on variance analysis. The process followed by the organisation for investigation and correction of variances should be commented upon. 13.5 In addi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pective profitability. 14.3 Care should be taken in splitting the joint costs in case of joint products and by products. The method adopted for separation of costs should be checked to ensure correctness and consistency. 14.4 It would help to separately identify the costs of production, selling marketing and handling customer services. 14.5 The cost auditor is expected to provide a thorough evaluation to bring out the products and/or services that are contributing more or less to the overall company performance. For convenience purpose, the products and/or services could be classified in groups with similar risk-return profiles. This classification may be different from the 'product groups' in the cost audit report annexures. 14.6 The analysis should separately appraise profitability of newly introduced products or services and also their proportion to the total profits of the organisation. The cost auditor should incorporate the profitability analysis of products discontinued during the period. 14.7 The term profitability should be taken with an extended meaning to include, apart from the concept of accounting profit, the ROI analysis as well. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... would provide better insight into the market or customer profitability analysis. Hence, the cost auditor could analyse the costs of acquiring the market or customer, costs involved in servicing and maintaining them and also costs involved in evaluating the potential thereof through market research. Example of how to look at Cost per unit when there are multiple customers and orders vary from quantities to deliveries. A Customer places the PO for X quantity to be delivered in four batches. Another customer places PO for Y quantity which is higher than Customer X, but delivery in equal number every month, which incidentally falls short of the minimum batch size. Here customer X, even though the quantity is lesser than customer Y, is economical to produce the required quantity as it costs less per item compared to Y. 15.7 This aspect of the report should specifically highlight the top five and the bottom five markets and/or customer/customer categories. This will help the company to understand the most profitable markets and customers/customer categories and also the ones that are consuming resources but not yielding profits. 15.8 In addition to the study of profitability ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y records and physical verification procedures. Benchmarking of the policy pursued by the company with the industry averages will enhance the value of performance report. 16.7 It will be appropriate to analyse the inventory into its components such as raw material and stores, work in progress and finished goods. For each of these categories, system of inventory control should be evaluated using tools like ABC or VAT or FSND analysis, EOQ technique, JIT system etc. The cost auditor should comment upon the quality of inventory asset using the inventory aging reports. 16.8 Another important component of working capital is receivables. Analysis of receivables is important for internal perspective (working capital management) and external perspective (customer management) as well. The cost auditor should peruse through the policy of the company regarding credit evaluation of customers, setting up of credit terms and credit limits, discount policy, collection delinquency procedures etc. 16.9 Trade credit from suppliers is the most crucial spontaneous source of working capital funding. The performance in respect of this could be critical for operational efficiencies and l ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... es of people. The time taken to recruit important positions may affect the performance adversely. 17.3 The factor returns from the manpower is in terms of growth in production and productivity, enhancement of skills and knowledge of the organisation. The cost auditor should analyse the figures of manpower productivity, idle time, overtime worked, absenteeism etc. These factors could be compared with the respective outputs such as increased production, increased sales etc. The criteria such as sales per person achieved, production per man hour etc. will add value to the Performance Appraisal Report. 17.4 The Performance Appraisal Report may include comments and observations about the employee learning and growth opportunities and their linkage with the improvement in overall performance of the organisation. 17.5 The cost auditor's checklist for this content area may be : Details of number of recruitments done, number of people left, the labour turnover ratios The data on idle time, absenteeism Manpower productivity reports Use of temporary or casual labour Turnover at the higher level of management Training and developmental prog ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... companies may have to defer part or whole of their revenues Inventory valuation - explicit rejection of LIFO method could change the inventory costs and thus profitability Property, plant and equipment - recognition of assets and depreciation may change, provisions on revaluation of assets are noteworthy Financial instruments - accounting for hedges and FOREX may result in profits or losses to be recognised or derecognized Construction contracts - there could be changes in contract revenues and profit measurement thereon Impairment of assets - recognition of provisions may impact profitability Intangible assets - certain existing assets may have to be derecognized Business combinations - some costs of M A cannot be capitalized 18.8 The impact of changeover has been explained in the Ind AS 101 - first time adoption. It may be noted that the impact based on this standard would be in the first year in which the new standards are applied. In the first financial statements, the adjustments will have to be made in the retained earnings, subject to some exceptions and exemptions. This standard may require an entity to (a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... k Management: The Performance Appraisal Report should include the risk analysis that may affect the future performance. These could be macro variables causing variations like the economic indicators of India such as industrial growth trends, Government policy on commerce and trade, interest rates, international growth etc. The risks facing the business could arise out of technological changes, entry of competition, stages of product life cycle, FOREX rate movements, shifts in customer preferences, credit risks, etc. The cost auditor should Identify the sources of various risks Assess the potential downside or upside effect thereof Comment whether the risks are worth taking or suggest the acceptable range Recommend risk mitigation tools and techniques to be used Evaluate the effect of the existing risk mitigation tools used by the company 19.6 Environment and Sustainability: The Performance Appraisal Report could provide insight into how effectively the company is following policies on CSR, environment and sustainability. The importance of economic, social and environmental performance hardly needs any justification. The CSR index could be formula ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... modified. The cost auditor could suggest best practice adoption approach from the benchmarked processes of the industry. This data is usually available in the published case studies. It would be appropriate to highlight the processes that should be re-engineered. 19.10 Human Resource Accounting: This is an extended analysis of total human resource costs, both explicit and implicit, which are capitalised at an appropriate discount rate. This value of human capital is reflection of the enhanced value that an organisation could create by owning the human asset. The cost auditor could observe the value of human asset and link it to the returns. This is an upcoming performance measurement criterion. 19.11 Value Added Analysis: The performance of a company could be measured in terms of the value based approach. The value added is measured as an absolute value created by the business and the distribution thereof to the employees and other providers of capital. The growth in the value added over a period of time could be observed and commented upon. 19.12 Performance of Intangible Assets: The business may have internally developed intangible assets. In financial accounting t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Full(absorption) Costing, Job, batch, process or contract costing Activity based costing, Time Driven ABC Cost reduction Total Quality management, Quality costing, Kaizen costing, Lean manufacturing, Value Analysis and Value Engineering, Six Sigma Pricing and decision making Target costing, Life cycle costing, Throughput accounting, Variable or marginal costing Total performance management Balanced Scorecard, Performance Prism, Performance pyramid, Business Objects, Business Intelligence 20.5 The cost auditor should be acquainted with the intricacies of these and such other tools and what it takes to successfully implement and use them. The success of Performance Appraisal Report would depend upon not how many performance measure are considered, but upon how they are evaluated and assessed with the help of various management accounting tools. APPENDIX A Planning for the Performance Appraisal Report Key Performance Indicators (KPIs) are simply the variables, independent or interdependent, in respect of which the goals can be s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Margins Gross margin % on total sales Gross margin % on segmental sales Gross margin % on new products Customer-wise Gross margin % Costs Element-wise cost % to total turnover and segmental turnover Cost composition nature-wise, variability structure, functional split Returns ROI on product groups ROI on geographical segments ROI on new products ROI on new markets ROCE Value added to total income Earnings per share (EPS) Dividend per share (DPS) Retention ratio Price-Earnings (PE) ratio Market price per share Balance sheet Current ratio, quick ratio Asset turnover (current and fixed assets) Growth in assets Capital expenditure % to total assets Debt-equity ratio Debt to total capital employed Productivity Efficiency Material Material cost % to total cost Material wastage as % to total input Contribution per unit of material used ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s of India 10. Generally accepted cost accounting principles (CAGAP) published by ICAI 11. Stock market information on prices, market capitalisation, market returns 12. Minutes of board meeting to the extent relevant 13. Personal meetings with the CEO/MD of the organisation and members of the audit committee and the Board 14. The cost accounting policy of the company 15. The cost accounting system of the company costing methods 16. The CENVAT and VAT records maintained by the company 17. The monthly MIS reports concentrate only on exceptional reports White Paper on MANAGEMENT CONCEPTS IMPACTING CURRENT PERFORMANCE FRAMEWORK: 1.1 Strategies can be seen as the process of building on or stretching a company's resources and competencies to create opportunities for the company to benefit from them. It means identifying existing resources and competencies and using them to create opportunities in the market. Strategies may require major and comprehensive resources changes for the company. This would be in terms of the extent to which resources can be obtained and controlled to develop strategies for the future. Strategies do affect ope ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in companies on resource-led strategies which tend to have significant cost implications. 1.3 Strategic Management is concerned with: Strategic Analysis Strategic choices Strategic Implementation All the above three segments are inter-related. Performance Analysis is evaluation of the results of the implemented strategies, in the context of strategies chosen after Strategic Analysis. Hence the Cost Auditor preparing the Performance Appraisal Report should be well versed with this cycle in the company under audit. The guidance note takes this perspective and presents a brief description of the Strategic Management process for the practicing members to appreciate the theoretical context behind the appraisal process. 1.4 The strategic management process is concerned with the issue of positioning the company in the context of its environment, competitive and others. For example, a small company may be engaged in finding a niche' in the emerging competitive market. The Strategic management process is also involved in finding ways to extend the company to a perceived future position with higher levels of competitive advan ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... g or continuing business operations. Small businesses typically need start-up funds, while medium and larger companies may need funding to expand operations or purchase competitors. Different types of funding are usually available based on the company's size and needs. Companies may choose to use traditional funding sources such as banks and equity investors or apply for government grants or venture capital funds. Each funding type offers different advantages to companies with different costs associated with them. Corporate financial management plays a cardinal role in organizational decision-making processes, enabling companies to manage risks adeptly, administer liquidity ratios and increase profit indicators. Central to corporate strategies are management accounting procedures that organizations select in the short and long-terms. (d) Intangible Resources: Performance analysis should also take into account the intangibles as this is gaining in importance in determining or shaping competitive advantage. For example, capacity utilization of machine and processes are increased often to improve the brand image and not for any focused Sales growth. In such cases, the c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... quality management strategies, controlling distributors' performance through training/financing etc., collaborative arrangements etc. are some of the ways in which company's own activities are beneficially linked to other organizations. This provides an avenue for reporting under performance analysis report. What has been the cost of such coordinating strategies and how much of competitive advantage of the company has improved or strengthened at present level? If such linkages with other companies are established as a matter policy, every year, then performance as to the cost efficiency in such coordinating/cooperating linkages can be an area for appraisal for the Cost Auditor. 1.8 Benchmarking A company's capabilities (resulting from core competencies) are to be assessed, ultimately, in relative terms. Items like capacity utilization at a given level Sales value, contribution ratio, investments in green initiatives, contributions to social responsibilities, are of no use unless just apositioning them with other companies' similar data. Such an attempt is usually known as Benchmarking. It is important to note that benchmarking technique, both internal and e ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... To -be : the goal state of the process; 2.2 Likely results of process mapping: Increased understanding of process, Increase consensus about the process, increased visibility into the process (Those who assume they know the process, without having mapped it, will probably find surprises when they map the process). 2.3 Steps-wise approach for Process Mapping: 1. Observe process 2. Document your observations 3. Identify all process steps Align all the steps horizontally 4. List the parameters that can change a product characteristic at each step (machine settings, supplies) 5. Identify VA and NVA steps: 5.1 Value Adding (VA) steps have the following characteristics: a. Something the customer would be willing to pay for b. Transforms the product or service (shape, smell, color) 5.2 Non Value-Added (NVA) steps are classified as: a. NVA Necessary : Activities that your customers do not want to pay for (it does not increase value in their eyes) but are required by the company for some reason: Accounting, legal, Rework, multiple signatures copies, counting, handling, inspecting, set-up, downtime, transporting, moving, delaying ..... X X X X Extracts X X X X X X X X Extracts X X X X
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